Commentaries

PMC Market Commentary: November 21, 2014

Much has been made in recent months of the emergence of the so-called “robo-advisor,” which are automated investment services designed to minimize human intervention. While the amount of assets investors have committed to such services is still extremely low, some industry observers consider robo-advisors to be a legitimate alternative to traditional financial and investment advice provided by a professional advisor. While the jury is still out on that issue, and despite the established popularity of do-it-yourself online trading tools, such direct-to-consumer/investor services historically have not proved successful when advice is required. For example, in the late 1990s several online services were established that aimed to eliminate the financial intermediary by providing direct-to-investor access to separate account management by professional money managers. Ultimately, these services ended up being shuttered because investors seek professional advice when making such relatively important decisions about their wealth. Do-it-yourself trading of ETFs in a “mad money” account is one thing; but entrusting one’s generational wealth to a robo-advisor is something not many high net worth investors are willing to do.

Advisors provide a slew of services and benefits that can’t easily be replicated using automation. There are several pillars, or sources, of advisor-created value that can be quantified. These pillars include financial planning; asset selection and allocation; vehicle and investment selection; portfolio construction and systematic rebalancing; and tax management. Advisors generate “alpha” for their clients in each of these areas that is not easily achievable in an automated fashion.

In many respects, the financial planning component of professional advice is the most important of the sources of advisor alpha, as it establishes the framework for all of the subsequent fiduciary decisions made by the advisor and client. In the process of establishing a relationship with the client, a partnership emerges whereby the advisor develops insightful solutions aimed at creating value for the client along several dimensions. In the end, such an “advisor value chain” will do more than simply construct a portfolio which outperforms a benchmark; it can help the client establish a lasting legacy incorporating charitable, philanthropic and generational features.

The initial phase of investment planning is asset selection and allocation. This source of advisor-created value is derived from the advisor’s ability to select from a palette of asset classes, and mold an asset allocation consistent with both the client’s risk profile and investment objectives. Academic and industry research often highlight the importance of the asset class selection and allocation decision. Advisors offer the ability to customize these decisions through the use of portfolio “tilts” or relative over-/underweights, risk mitigators such as liquid alternatives, and tactical or dynamic strategies.

Investment and vehicle selection is also an important source of advisor-created value. Once the asset allocation has been crafted from a palette of asset classes, the next step in the advisor value chain is to breathe life into the asset allocation through selecting the most appropriate vehicles and investments, and then thoughtfully knitting them together to create a perfected portfolio customized to the client’s unique objectives. The advisor assists with such decisions as active vs. passive, separate account vs. mutual fund vs. ETF, and whether to incorporate a fund strategist as part of the allocation.

The combined steps portfolio construction and systematic rebalancing form the bridge from financial and investment planning to the implementation and execution of the strategy. Key elements of this component is asset location advice (i.e., how to allocate assets across registration types) and determining the optimal rebalancing frequency for the client.

After the portfolio has been properly allocated, constructed and implemented, an ongoing source of an advisor’s value contribution comes in the form of tax management alpha. Tax management alpha is the excess return generated through thoughtful management of individual tax lots within and across the client’s accounts.

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.